Volcker Schmolcker: Prop Trading Is Alive and Well

After suggesting a few weeks ago that moves by financial firms to unwind their proprietary trading operations might be a little disengenuous, Michael Lewis pushes his case further today. According to Lewis, big banks will continue to use shareholder capital to initiate trades, but — cleverly — will say that they are no longer doing any such thing.

The supposed shift in giant banks’ business models results from the “Volcker rule,” a provision of the Dodd-Frank financial reform law that seeks to restrict the kinds of trading activities banks can initiate on their own behalf.

The trick, says Lewis, is to pretend to be acting on behalf of a fictional customer. Lewis talked to Robert Wosnitzer, a former Lehman Brothers bond man who’s writing a history of prop trading:

“One trader I interviewed,” Wosnitzer says, “said that from here on out, if he wants to take a proprietary position in a credit, he will argue that he bought the position because a customer wanted to sell the position, and he was providing liquidity; and in order to keep the trade on, he would merely offer the bonds 10 basis points higher than the offered side, so that he will in effect never get lifted out of the position, while being able to say that he is offering the bonds for sale to clients, but no one wants ‘em. When the trade finally gets to where he wants it — i.e., either realizing full profit, or slaughtered by losses — he will then sell it on the bid side, and move on.

Of course, there is all sorts of flawed logic here, but the point is that…there are a hundred different ways to claim to be acting as an agent or for a customer.”

Lewis points out an awkward fact: Traders at places like Goldman Sachs aren’t typically the best at making bets in the financial markets. If they were, they’d work for hedge funds or other companies that pay people more for their investment insight. So why are they going to such great lengths to secretly do a risky thing they’re not that great at? The simple answer is that customer service simply isn’t that lucrative anymore.

The solution, per Lewis: “to ban any sort of position-taking at the giant publicly owned banks. To say, simply: You are no longer allowed to make bets in the same stocks and bonds that you are selling to investors.” Sounds simple enough.

mtaylor [at] observer.com | @mbrookstaylor

Volcker Schmolcker: Prop Trading Is Alive and Well